Land Rent Risk Reduction

Some producers are rolling back the clock to crop-share leases

As land rents skyrocket, producers are using creative strategies to manage risk if crop prices drop. One way is the re-emergence of the crop-share lease.

"Four years ago, all of my land was on a cash-rent basis. For 2011, 30% is a 50-50 crop-share lease arrangement with different landlords," says Steve Ruh of Sugar Grove, Ill., who rents all the land he farms. Landlords are realizing that given where prices are right now, they might make $300 per acre with a crop-share lease, far greater than cash-rent payments, says Ruh, who grows corn, soybeans, wheat and alfalfa. It’s good for them, while also good for Ruh to reduce risk.

Ruh isn’t the only one experiencing a cash-rent reversal.

Four years ago, all of Steve Ruh’s land was rented on a cash-rent basis. This year, 30% of the Sugar Grove, Ill., producer’s rented land is a 50-50 crop-share lease with different landlords. The arrangement allows landlords to pocket more money per acre and helps Ruh reduce his risk.

"We were entirely on a cash-rent basis with landlords but switched a lot to crop shares or a crop-share formula this year," says Doug Holliday of Greenfield, Iowa. "Investors want the price uptick, part of the action."

It’s hard to know just how widespread such anecdotal evidence is because the change isn’t yet reflected in statistics. In the past decade, there has been a shift from share-rental agreements to cash rents, driven primarily by landlords, a number of whom live out of state and aren’t involved in agriculture.

Tenants, too, have been willing to make the switch. As farms become larger, it’s easier for tenants to keep track of cash rents compared with crop-share arrangements if they’re renting from a large number of land-lords, says Michael Duffy, an Iowa State University ag economist.

Flexible Leases. Thinking outside the box, more farmers in the past six months have been seriously talking about using flexible cash leases, notices University of Illinois ag economist Nick Paulson. Flexible cash leases can take on a number of forms and be as simple or as complicated as you make them, he says. The rental includes a fixed cash component and a share component where the total rental payment can fluctuate based on prices, revenues, yields or whatever metric the producer and landowner agree on.

Paulson has also heard from producers who are paying bonuses to landlords when incomes are high, even though this is not directly incorporated into the fixed cash-rent contract.

"The idea behind this is to share some of the good times with landowners in the hope that they will be more understanding or willing to negotiate lower rents if the outlook takes a turn for the worse," Paulson says. "The biggest fear with most of the producers I talk with is not how they are going to make high cash rents work in 2011—even with $300 or higher cash rents—but how are they going to work long-term?"

Cash-Rent Leases. Taking a nearly three-decade look, Iowa cash rents comprised half of all land rental agreements in 1982 and that number increased to 75% by 2007. Duffy estimates that cash rents will equate to 78% this year. However, fertilizer and seed costs have doubled in the past decade, and, as a result, land as a percentage of total production costs has not actually increased in recent years, Duffy says.

Paulson says the trend of rising cash rents nonetheless has significant implications for farm profitability and the risk exposure facing both the producer and the landowner.

Illinois farmer Ruh cuts his risk and costs by using GPS to vary fertilizer applications based on desired yield and soil tests. The service costs about $5 per acre, but the techno-logy puts fertilizer where it’s needed and boosts yields.

For Chase, Kan., farmer Doug Keesling, the answer to risk management is diversity, which reduces the odds of any one crop problem putting the entire farm at great risk. He grows wheat, corn, milo, soybeans and alfalfa, and raises cattle.

Keesling’s diversification doesn’t stop with his crop and livestock mix. He also has a manure company. He buys manure from poultry and livestock producers and uses it to significantly cut nitrogen costs on his land. He also spreads manure for other farmers.

As land rents go up and the potential for price volatility increases, Keesling says, cost control is key.

To further reduce rental land risk, Keesling contracts input costs well in advance, even for fuel. As a result, he knows his break-even costs. "When crop prices are above break-even, I can lock in a profit," he says.

Sometimes, looking hard at costs means you pay more up front, but doing so can actually reduce risk. For example, Keesling has hired a full-time mechanic. That might seem expensive, but the numbers show it saves money when compared with taking equipment to town to be repaired.

Making a Switch on Distant Land. One way Iowa farmer Holliday is reducing rental land risk is to cut his fuel cost by not farming land farther away. With the cost of fuel this year, it makes more economic sense to rent out some land he owns.

"With current fuel prices, I don’t feel I can travel very far to farm," he says.

To offset price risk, Holliday is also making better use of forward pricing. He’s using puts to protect against downside risk, calls to protect the upside, and hedge-to-arrive contracts, which allow him to set the basis later.

He also uses USDA’s Average Crop Revenue Election (ACRE) program, which he says is an excellent risk management program that hasn’t been widely adopted because of its complexity.

Holliday is also a firm believer in using the federal crop insurance program as a way to negate risk.

Risk of Losing Land. For farmers who rent from out-of-state landowners who might not be following trends that closely, there’s the risk of losing land to another farmer. As a result, it’s important for tenants to keep landowners informed and pay bonuses to landlords when crop prices are high, encourages Kansas State University economist Kevin Dhuyvetter. "Average rents have gone up, but in most cases they have not kept pace with land values," he notes.

It’s imperative that landowners and tenants have good communication, Dhuyvetter adds, so that rents go up gradually on a year-by-year basis and not take a huge jump in any one year. Such communication can help both parties understand how rents will need to decline if crop prices crash.

A transparent rental arrangement, probably the most critical factor, Dhuyvetter says, can occur when both sides talk to each other. "What producers do not want is for landlords to wake up one day and discover that they’ve been paid half of what the land is worth," Dhuyvetter adds. "Too often, cash rents go unchanged for four to five years, which can be problematic in the current high-volatility market."